Rates to rise if prepayment fee is waived: Banks tells RBI

ET Bureau|

Updated: Oct 25, 2011, 01.41 AM IST

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MUMBAI: Heads of banks from State Bank of India to Bank of Baroda will tell the regulator today that if it enforces waiver of prepayment penalty on home loans, interest rates on all customers borrowing for a home would rise by as high as 1.5 percentage points.

Banks reluctant to part with easy profits from pre-payment penalty are saying they would pass on the 'opportunity loss' through higher interest rates on mortgages affecting everyone, instead of just who prepay, say two people familiar with the situation.

"Banks levy prepayment charges on long-term loans, and if they are prepaid it exposes banks to asset liability mismatch," said SC Kalia, executive director at Union Bank of India. "Banks could consider waiving these charges for self occupied properties and not investors. Banks would have to factor in this cost if they decide to do away with prepayment charge."

Chairmen of banks in their customary pre-monetary policy meeting with the Reserve Bank of India governor Duvvuri Subbarao plan to impress that waiver of pre-payment may not be such a great service to customers. Fee income, a rising proportion of banks' net profits in recent years will seriously get eroded if these charges are waived.

Already, the National Housing Bank that regulates housing finance companies such as HDFC and LIC Housing Finance has ordered them to stop charging the penalty. Lenders may have to increase rates for new loans by 100-150 basis points, forecast IDFC Securities. A basis point is 0.01 percentage point.

"This move will potentially lead to loss of revenue," said Amitabh Chaturvedi, managing director and chief executive officer of Dhanlaxmi Bank. "For shorter duration, loans the prepayment penalty could be lower but for long duration, loans banks should be permitted to charge at least 2%."

But a panel headed by former Sebi chairman M Damodaran said there was no justification for such charges as borrowers anyway bear the risk of interest rates in the floating rage regime.

"Banks should not impose exorbitant penal rates towards foreclosure of home loans and a policy should be devised to ensure that the customer is not denied of opportunity to enhance his economic welfare by making choices such as switching over to other banks/financial entities to enjoy the benefits conferred by market competition," the committee recommended.

Banks now charge around 2-2.5% on the pre-payment of a home loan, which for some customers becomes impossible to shift even if he is offered attractive rates by rivals.

Banks are probably blowing out of proportion their potential loss if they waive pre-payment penalty.

"The waiver of prepayment penalty on home loans gives the customer the flexibility to prepay the loan, irrespective of amount and for banks, this should not have any major impact as income from such charges is very low," said Suresh Sadagopan, principal financial planner at Ladder7 Financial Advisories.